TRACE made it to the EU Commission’s agenda. Yet another burden approaching? Or an opportunity?

Tue 26 Jan 2021

On 24 September 2020, the European Commission published Communication COM (2020) 590 (final) regarding the action plan in respect to the Capital Markets Union.  

Action 10 of this plan envisages a EU legislative initiative by Q4 2022 to introduce a common, standardised, EU-wide system for withholding tax relief at source, based on the OECD Treaty Relief and Compliance Enhancement (“TRACE”) Implementation Package. 

What is this about?   

The initiative is a long-anticipated revival of the 2009 OECD TRACE initiative, which was elaborated in the 2013 TRACE Implementation Package. TRACE is to a certain extent similar to the U.S. qualified intermediary regime, in place since 2000; a regime with which banks are particularly familiar. 

The idea lies in the adoption of a standardized “Authorized Intermediary” (“AI”) system for achieving withholding tax relief in respect of cross-border portfolio income. 

In general, under relief at source procedures, withholding relief or exemptions under the double taxation treaties are applied when the underlying income payment is made, provided all necessary information is available, and declarations are made. 

AIs will be able to apply, on behalf of their account holders, withholding relief at source on income and capital gains from securities (in principle, issued in the EU member states) by properly identifying and communicating relevant tax entitlements to those who need to withhold the tax in the source country on a pooled basis, i.e. without disclosing the account holders. 

This will significantly reduce costs beneficial owners and financial intermediaries face compared to processing withholding refund claims. 

How is this expected to work? 

Assuming the TRACE principles would be followed –  (which is likely –), a financial intermediary seeking to benefit from the system will need to apply for AI status by concluding an AI agreement. Although the OECD TRACE package refers to authorization in each source country, we would reasonably expect that the EC may introduce a system allowing confirmation of authorization in all EU member-states, but this remains to be seen. 

The AI will have certain documentation and reporting obligations and is expected to be able to choose to assume primary withholding responsibility (direct withholding and deposit obligations) or not (i.e. instruct upstream withholding agents to withhold, where applicable), as under the QI regime. 

For example, an AI not assuming primary withholding responsibility would first document each of its direct and indirect accounts (held through “contractual intermediaries”, i.e. non-AIs) eligible for tax relief for WHT on the income from EU source country with uniform self-certification templates for beneficial owners.  The AI will send to the withholding agent its intermediary declarations, pooled information regarding the countries in which the investors are resident for tax purposes and instruct the agent regarding withholding rates applicable to the pools (as illustrated below). 

Then, the AI will need to report on a regular basis. In the package, one of the options is that the AI would report the required information to its local tax authority, which would then exchange the information on an automatic basis with the source countries. It seems likely that the EC may support such option, taking into account an already existing similar architecture for CRS And DAC 6 reporting.

The compliance of the AI with its obligations will likely need to be confirmed by an independent reviewer’s report (possibly, leaving the choice between an internal or external review, as is the case under the QI regime). Following the package, such review should not be required more often than every third year (as is also the case with the QI regime).

Who is expected to be concerned?

The OECD TRACE package does not as such limit the financial intermediaries that can be eligible to apply for the AI status.  Under its definition, it can be any person that acts on behalf of another person such as a custodian, broker, nominee or other agent, including fiscally transparent entities.

The choice will be most obvious for banks acting as intermediaries, holding e.g. securities accounts for their clients. Many banks already have significant experience with the QI regime. The implementation effort for institutions already familiar with this regime can be expected to be relatively limited given the staff expertise, internal systems and procedures, and controls for QI, which would need to be enriched and adjusted for TRACE purposes.

However, the mechanism should provide opportunities for other intermediaries as well. One of the many, but less obvious, examples would be the possible application of the regime to investment funds, and to transparent investment partnerships such as e.g. Luxembourg SCSp. 

It is currently possible to set up procedures/filings to reduce withholding tax in the hands of the investors/limited partners of e.g. transparent funds and partnerships, applying the tax treaties between the source countries and the partners’ respective tax residence countries through full tax transparency. However in practice, this often gives rise to difficulties, or negative cost/benefit balances.  The expected withholding relief at source system may eliminate such obstacles.

When is this expected to apply?

As mentioned above, the Commission is keen to put forward a legislative initiative by Q4 2022. Of course, Member States will need a bit of time to implement such new rules, and those wishing to adopt AI status would also need sufficient implementation time.  A realistic timing could be 2024; however it is to be seen when the legislative initiative will effectively crystallize.

AI compliance, but also commercial advantages, and benefits for clients/investors

As is the case with the QI regime, the expected EU withholding at source relief system, inspired by TRACE, would come with a compliance cost and most likely periodic review cost.  However the regime is expected to allow not only banks but likely also investment funds and other investment vehicles to act under the AI status to achieve withholding reductions and exemptions at source for their clients and investors in an efficient and simplified way (with the cash flow advantage of applying a reduction or redemption at source through the AI, rather than clients and investors having to go through a lengthy, often more burdensome, and in certain cases, unprofitable reclaim procedure). The regime should be optional; but there will likely be a commercial advantage of adopting AI status rather than being a non-AI (as is the case with the QI regime). 

At Mazars, we are closely following this EU initiative, and we will of course be ready to fully assist you as and when the regime will need to be implemented.